Revenue Recognition: It’s Not Sexy but You Need to Know Andrew Reading, Dopkins & Company LLP Eric Lucas, KPMG LLP David Antoni, KPMG LLP National Society of Accountants for Cooperatives 2019 Tax, Finance & Accounting Conference for Cooperatives Denver, CO August 5, 2019 1 The information in this document is not intended to be “written advice concerning one or more Federal tax matters” subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials provided to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in the materials. The information in this document is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. 2 Agenda • ASC 606 Overview • Cooperative Implementation Considerations and Best Practices • Tax Revenue Overview • Tax Considerations 3 Key Concepts • Replaces substantially all prior guidance • Effective January 1, 2019 for calendar issuers • Scope – all contracts with customers except where other guidance is provided in ASC (ex. Leases etc.) • Principles based – need to document judgments • Revenue is recognized based on a 5 step model – Applied on a contract by contract basis – Portfolio approach as practical expedient 4 The Five-step Model An entity recognizes revenue to depict the transfer of promised goods or services to Core customers in an amount that reflects the consideration to which the entity expects Principle to be entitled in exchange for those goods or services 1 Identify the contract(s) with a customer 2 Identify the performance obligations in the contract 3 Determine the transaction price 4 Allocate the transaction price to the performance obligations in the contract 5 Recognize revenue when (or as) the entity satisfies a performance obligation 5 The Five-step Model An entity recognizes revenue to depict the transfer of promised goods or services to Core customers in an amount that reflects the consideration to which the entity expects Principle to be entitled in exchange for those goods or services 1 Identify the contract(s) with a customer 2 Identify the performance obligations in the contract 3 Determine the transaction price 4 Allocate the transaction price to the performance obligations in the contract 5 Recognize revenue when (or as) the entity satisfies a performance obligation 6 Step 1 - Identify the Contract • “An agreement between two or more parties that creates enforceable rights and obligations”. – The accounting reflects the legal rights and obligations • Considerations: – Written contracts/e-mails – Purchase orders – Standard terms/conditions – Verbal agreements – Past business practices – Combining contracts 7 Step 1 - Identify the Contract • Cannot apply 5 step model until a contract is deemed to exist as part of Step 1 • Existence criteria: – Approvals and commitment to perform by both parties – Rights of both parties and payment terms are identified – Commercial substance exists – Collection is probable (likely to occur) • Consider contract termination provisions • Contract modifications 8 The Five-step Model An entity recognizes revenue to depict the transfer of promised goods or services to Core customers in an amount that reflects the consideration to which the entity expects Principle to be entitled in exchange for those goods or services 1 Identify the contract(s) with a customer 2 Identify the performance obligations in the contract 3 Determine the transaction price 4 Allocate the transaction price to the performance obligations in the contract 5 Recognize revenue when (or as) the entity satisfies a performance obligation 9 Step 2 – Identify Performance Obligations • A performance obligation (PO) is a promise to deliver a good or service that is: – Capable of being distinct (customer can benefit from on own or combining it with other resources readily available to customer) – Distinct within the context of the contract (separately identifiable) 10 Step 2 – Identify Performance Obligations • Identify all promised goods and services in the contract (explicit vs. implicit) • Determine if they meet PO definition • Practical expedient – immaterial in context of the contract 11 Step 2 – Identify Performance Obligations • Key Considerations – Warranties (assurance type vs. service) – Customer options for additional goods/services including loyalty programs – Shipping and Handling 12 The Five-step Model An entity recognizes revenue to depict the transfer of promised goods or services to Core customers in an amount that reflects the consideration to which the entity expects Principle to be entitled in exchange for those goods or services 1 Identify the contract(s) with a customer 2 Identify the performance obligations in the contract 3 Determine the transaction price 4 Allocate the transaction price to the performance obligations in the contract 5 Recognize revenue when (or as) the entity satisfies a performance obligation 13 Step 3 – Determine the Transaction Price • Amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties (i.e. certain sales taxes). • Based on contract terms and customary business practices – Does not consider cancellation, renewal or modification terms 14 Step 3 – Determine the Transaction Price • Determined at contract inception – Fixed cash and any noncash consideration – Expected variable consideration • Refunds • Returns • Discounts • Performance bonuses • Rebates • Penalties • Royalties 15 Step 3 – Determine the Transaction Price • Other transaction price considerations – Significant financing component – Consideration payable to the customer (i.e. Slotting / Coupons ) – Sales and similar taxes – Nonrefundable upfront fees 16 The Five-step Model An entity recognizes revenue to depict the transfer of promised goods or services to Core customers in an amount that reflects the consideration to which the entity expects Principle to be entitled in exchange for those goods or services 1 Identify the contract(s) with a customer 2 Identify the performance obligations in the contract 3 Determine the transaction price 4 Allocate the transaction price to the performance obligations in the contract 5 Recognize revenue when (or as) the entity satisfies a performance obligation 17 Step 4 – Allocate Transaction Price to Performance Obligations • Key concept – allocate an amount to each PO representing the consideration to which the entity expects to be entitled as a result of transferring control of the underlying goods or services to the customer. • Generally allocated using stand-alone selling prices 18 The Five-step Model An entity recognizes revenue to depict the transfer of promised goods or services to Core customers in an amount that reflects the consideration to which the entity expects Principle to be entitled in exchange for those goods or services 1 Identify the contract(s) with a customer 2 Identify the performance obligations in the contract 3 Determine the transaction price 4 Allocate the transaction price to the performance obligations in the contract 5 Recognize revenue when (or as) the entity satisfies a performance obligation 19 Step 5 – Recognize Revenue • Recognize revenue when control is transferred in connection with the satisfaction of a performance obligation a)over time or b)at a point in time • Transfer of control - customer has the ability to direct the use of the asset and receive substantially all of the related remaining benefits 20 Step 5 – Recognize Revenue • Indicators that control has transferred – Customer is obligated to pay Cooperative for the transferred asset – Customer has: • Legal title • Physical custody • Significant risks and rewards of owning asset • Accepted asset • Indicators are not solely determinative – often require significant judgment 21 Step 5 – Recognize Revenue • Over time vs. point in time - assessed at contract inception • Over time if any one are met, otherwise recognized at a point in time: – Customer simultaneously receives and consumes benefits as entity performs – Customer controls the asset as the entity creates or enhances the asset – No alternative use and an enforceable right to payment 22 Step 5 – Recognize Revenue • Over time – use output or input methods that reasonably measure progress toward completion of POs • Must be consistently applied to all similar transactions • Point in time – when customer obtains control of the asset underlying the performance obligation 23 Step 5 – Recognize Revenue • Key considerations: – Customer’s unexercised rights (i.e. breakage) – Repurchase agreements – Consignment arrangements – Sales to distributors – Bill-and-Hold arrangements – Customer acceptance – International sales (when has control transferred) 24 Other Overall Considerations • Licensing and rights to use (IP) • Principal vs. Agent (gross vs. net reporting) • Onerous (loss) contracts • Contract costs – to fulfill and obtain 25 Transition • Full Retrospective application to all periods presented. Certain practical expedients with disclosure • Modified Retrospective – Applied to either (a) all contracts at the date of initial application or (b) only contracts